2023-05-03 23:41:18 ET
Summary
- Net sales improve due to higher prices of products sold.
- Sales volumes are struggling, but the company reassures shareholders.
- The guidance for FY 2023 has been revised upward. Inflation slows but still persists.
The Clorox Co. (CLX) 's Q3 2023 was positive overall, however, there are still problems to be solved. While higher prices due to high inflation prevented a margin meltdown, sales volumes suffered a double-digit decline. Guidance for the full FY 2023 has been revised upward.
All quotes you will find in this article belong to the conference call that you can read or listen to by clicking on this link .
Comment on Q3 2023
First of all, here is the income statement for Q3 2023.
Compared to Q3 2022, the company achieved net sales up $106 million, and gross profit up $151 million. In any case, in spite of these two improvements, looking at the final part of this table we can see that Clorox still failed to generate profit; on the contrary, it made a loss of $209 million. At first glance this may seem like a bad result, especially when compared to Q3 2022, but there is good reason not to worry too much.
As can also be seen in this table, the key to this loss is Goodwill, trademark and other intangible asset impairments. In short, a $445 million impairment in the vitamins, minerals and supplements (VMS) segment that affected profitability.
This impairment had a major weight within this quarterly, as it is responsible for $2.92 less in the calculation of GAAP EPS. Without it and with other minor adjustments, Non-GAAP EPS is far better.
In this case I prefer to focus more on the Non-GAAP measure rather than GAAP because the impairment is not a monetary cost, so there was no cash outflow from the company. Moreover, it certainly does not occur every year. Personally, I think the most important aspect in a company is cash flow, which is why I would not give too much credit to the disappointing GAAP EPS of $(1.71).
In fact, if we look at free cash flow, there was an improvement in this quarter in both nominal and percentage terms.
Finally, to wrap things up, Kevin Jacobsen ((CFO)) also spoke on the subject, specifically why this impairment was accounted for:
VMS is a small portion of our portfolio. It's about 3% of sales right now and has continued to face challenging market dynamics from a category perspective, what we're seeing coming out of COVID. And then, of course, we've highlighted the performance issues on that business. And we've reassessed that business as it relates to the role it plays in our portfolio.
That said, now let's look at the individual segments and how they performed.
Overall, they generated net sales growth of 6%. Lifestyle was the best by recording 15% growth, right behind Health and Wellness with 7% growth. Household and International achieved little growth. Weighing on the profitability of Health and Wellness and International was once again the impairment discussed earlier.
But where did this growth come from?
At first glance, it is evident that net sales of Clorox have increased exclusively due to major price increases; in some cases even more than 20%. Volumes, as a result, have decreased and not even slightly I would say.
A reduction in organic volume of 11% from the previous quarter and 12% considering the last 3 quarters is something that raises more than one doubt. Yet, the CFO does not seem to be worried, as he expected such a result; the company is already projected toward the new strategy to be used in the future to achieve growing volumes again.
I would expect price mix to continue to moderate and the volume declines to moderate as well as we cycle through this pricing. And so as I said, short of any future pricing being taken, I think we've probably got a three more quarters or so, we're seeing price/mix driving the top line to a greater extent of volume. But I think that will level and balance out as we look further out into our fiscal year '24 and so I think that's when we get to a more steady state of volume.
Finally, during the conference call, it was discussed how market share may be affected by constantly decreasing sales volumes. Could this be a problem for Clorox?
At the moment it seems not. As pointed out by Linda Rendle ((CEO)), the company prefers to look at metrics such as dollar share rather than unit share, as it better reflects the overall value of their brand. Following this approach, 5 of their 9 businesses have seen an increase in their share thanks largely to price increases.
But how much longer will product prices experience major increases? Probably not for much longer.
We believe Q3 will be the strongest benefit from pricing. As we move into Q4, we're now lapping two price increases, the first two rounds we took. And so I would expect that we'll see less benefit from pricing in Q4, essentially offset by more moderating cost environment.
So, with inflation coming down we can expect less and less aggressive pricing and probably less struggling sales volumes as well. It is a process that takes time, however, as inflation still remains a problem, especially for commodities. Suffice it to say that in Q1 2023 commodity inflation was 330 basis points, while in Q3 2023 it was 230 basis points. The impact of inflation in the supply chain for the entire fiscal year is estimated at $400 million; half due to raw materials and the other half to other areas such as logistics.
So it is not surprising that the company raised prices so much, otherwise the cost of inflation would have reduced profit margins too much.
Indeed, with such increases, the company has held up well in the inflationary environment and Q3 2023 recorded a gross margin of 41.80%, the best in a year and a half. However, there is one problem, which is that despite this improvement the gross margin is still far from pre-pandemic values (about 44-45%). There was a lot of talk in the conference call about this issue.
Personally, I think the company is doing what it can and the improvements are evident, so I would not be concerned about a gross margin slightly below the past average. As the CFO also specified, there are elements that cannot be controlled but have an important impact.
The challenge with the gross margin, I know there's a lot of interest in exactly when we get to pre-pandemic levels is. On the elements, we control, I feel very good about the progress we're making and we've talked a lot about those drivers. I would say those initiatives are primarily on track or exceeding our expectations. But the reality is there's a real impact from the areas we don't control, either supply chain disruptions or inflation. And as I said in the past, I really think that inflationary component will either accelerate or delay our time to recovery, depending on how that plays out over the next 12 months to 24 months.
Finally, I conclude this quarterly analysis with the guidance for FY2023. There are many items that were updated positively and a few that remained unchanged.
Among the positive updates:
- Net sales are now expected to be between a 1% and 2% increase; compared previously to between a 2% decrease and 1% increase.
- Organic sales are now expected to be between a 3% and 4% increase; compared previously to between a flat and 3% increase.
- Gross margin is now expected to increase between 250 and 300 basis points, primarily due to the combined benefit of pricing, cost savings and supply chain optimization, more than offsetting continued cost inflation. This is an increase from previous estimates of between 50-100 basis points.
- Adjusted EPS is now expected to be between $4.35 and $4.50, or a 6% to 10% increase, respectively. This compares previously to between $4.05 and $4.30, or a 1% decrease to a 5% increase, respectively. Excluded from the account is the non-cash impairment of the VMS business.
Instead, the unchanged estimates are:
- Advertising and sales promotion spending of about 10% of net sales; keeping this expense high is important to support pricing.
- Foreign exchange headwinds continue to represent about a 2-point reduction in sales.
For further details see:
Clorox: Volumes Fall But Gross Margin Is Recovering